With those words, Joe Nicosia began his annual economic update at the Mid-South Farm & Gin Show in Memphis.
“In 2011 at the Gin Show, we talked about scarcity. We witnessed the highest prices that we’ve ever seen,” said Nicosia, CEO of Allenberg Cotton Co. in Cordova, TN. “We knew we were going to have shortages in supply going into the year. And really, the question was, how are we going to get through this year?”
The answer? By the hair on our chinny chin chin. Carryover stocks in the U.S. dropped to 2.6 million bales in crop year 2010/11 from 3.1 million in 2009/10. As carryover dropped, prices went the other way in dramatic fashion.
Nicosia asked at that time: “Will 2011 be the best year ever in cotton? It’s setting itself to be, without question. That would have been almost impossible to believe three years ago.”
Then the U.S. was sitting on 6.3 million bales of carryover cotton. It was at 9 million just a year prior. Decreases in acreage did their job. Carryover was cut in half (3.1 million bales) in crop year 2009/10. World carryover during that time period dropped from 60.8 million bales to 47 million.
In 2011, Nicosia then dropped the hammer on what the world needed and what growers came to hear. And it was grow more cotton. Much more cotton.
“The key was when prices were at $1.30 (per pound), they were high enough to entice all of the acreage to be planted in the world that you could imagine,” he said. “So the conclusion was, we were going to 90 cents, or $1.80. That seemed realistic.
“But at $1.30, it didn’t do anything. It wasn’t high enough to price out demand, and it wasn’t low enough to try to pull back and control supply.”
It was a case of equilibrium in supply and demand.
The Hangover Effect
But that was last year and the old-crop run up to $2.40 per pound and $1.30 new-crop left us with what Nicosia called the “hangover effect.” Two dollar cotton was 10 months in the past and the 2011/12 crop is now trading at less than half that price.
Nicosia said that as we witnessed a record expansion in cotton area, we saw a contraction in cotton demand, and China’s determination to build a reserve buffer of stocks.
But at the end of the 2010/11 crop year, world production massively outpaced consumption.
“This is the one thing I think people missed. I know we missed it,” said Nicosia. “Demand has contracted and hasn’t come back yet.
“The confluence of these events is creating one of the largest global ending stocks in history, and there is huge uncertainty about what will happen. With global use of less than 110 million bales, an immense surplus exists.”
And despite record drought in Texas and problems with monsoon flooding in Pakistan, prices still have not responded.
So who made up the difference in stocks that zoomed far ahead of consumption in 2010/11?
“It’s not a surprise, and I’ve been telling you this for the past three years. The number one nemesis in the world is India,” Nicosia continued. “The United States went up 3.75 million acres and India went up 2.5 million.
“Well, they already had the largest acreage in the world by far, then you throw another 2.5 million acres on top of that. These two countries – the United States and India – accounted for 50% of the acreage increase. It’s not too far away – India will become the largest cotton producer and the United States will become the largest exporter.”
The Red Dragon
Today we have a new player in the game, and Nicosia said we need it. It’s the China Reserve Program.
“It has taken millions of bales off the market,” he continued. “And herein are the questions that lie before us for the next 6 to 18 months. In 2009 and 2010, the Chinese Reserve sold 16.6 million bales into the marketplace. They had roughly 18 to 20 million bales of stocks in reserve when prices were lower.”
But by October 2010, China had only 1.3 million bales left. Nicosia said that was the last hope to keep cotton prices down. “And they sold all of that in their domestic marketplace,” he explained. “So once they finished, they found themselves in a shortage and they had no policy measures and no bullets left to control prices. If you look back, that was about the time prices started to take off for the rest of the year.”
This was not a pill China wanted to swallow. It was not the ideal place for the Chinese to be in.
“So what did they do?” asked Nicosia. “They issued out a reserve price at very high levels; substantially higher. They set it at $1.18 per pound to their local farmers.”
As prices started to drop below $1.18, China moved and made major purchases on the world market, reaching 4 million bales.
“Today, the Reserve has bought over 12.4 million bales of their own cotton,” Nicosia said. “Total purchases should reach 15 to 18 million bales, so they’ll have between 15.5 and 18.5 million bales in reserve. If you’re wondering where supply went, it went straight to them.”
Today the world has a glut of cotton stocks, but at the same time, because of free stocks (stocks not in China’s reserve and available for sale) supplies could be as tight as they were in the last marketing year.
Nicosia said 90-cent December futures can provide an opportunity for growers around the world who wouldn’t otherwise have an opportunity of selling at $1.27.
“That’s still a reasonable price,” he explained. “And they’re going to grow another large crop in 2012/13. But not as large as they would otherwise, and not as large as last year.”
A Look at the 2012 Cotton Market
The answer to these questions will drive 2012 prices:
- How long will China continue to support global cotton prices with its reserve purchases?
- What will China do with its cotton reserve?
- How sustainable are the area increases of 2011?
- Has global demand been deferred or lost?
Demand is still at the core of any direction the market takes, and the question is whether demand is on hold or lost.
“A lot of people thought that when new-crop supplies came into the world at cheaper prices, we would see consumption move up fairly substantially,” said Nicosia. “But that hasn’t been the case. Poor business conditions around the world, the recession we’ve been in and the problems in the EU have all retarded consumption.”
Nicosia said that world population grows at 2% per year, but growth in cotton consumption has not followed. “You have more people so you need more things, more clothes,” he explained. “And we know we’re going through a situation where many of the developing countries – namely India and China, which have 2.4 billion people; roughly a third of the world population – are increasing their own standard of living, thus consumption should really be exploding. And yet it has gone down. So again, is this demand lost, or is it demand deferred?
Signs point to the likelihood that demand is deferred:
- Tight supplies of cotton and the resulting high cost of cotton manufacturing caused a some clearing of the supply pipeline.
- Retailers bought conservatively.
- Christmas sales were robust and inventories are low.
With those factors in mind, deferred demand may soon come into play.
“Is there light at the end of the tunnel?” asked Nicosia. “I think so. Remember we talked about 2008/09 and what led to the pushback in consumption. Today the tight side of cotton that we had a year ago and the high cost of manufacturing is causing the pipeline to contract. Everybody from retailers, yarn manufacturers, apparel companies – everyone cut their inventories. And they should have.”
2012/13 by the Numbers
“When we look at the U.S. balance sheet … we find ourselves in an extremely tight situation,” Nicosia said. “In 2011 we were at 3.8 million bales (of carryover). But the key number here is the export number of 11 million bales, substantially less than where we were last year, and yet (Allenberg’s) number in exports is higher than 11 million bales.”
The Allenberg carryover number is 3.8 million bales. “That, in and of itself, is a very positive factor that is taking place,” said Nicosia. “So now we’ve got tight free stocks in the world and a U.S. carryout number that is less than the current USDA estimate.”
Black clouds on the horizon for 2012/13 continue to be the drought in Texas followed by increases if input costs.
“We think U.S. acreage is going to drop 1.8 million acres to 12.9 million,” said Nicosia. With price the ‘X’ factor, “World acreage is going to drop 4.6 million. However, we are right on the cusp of that 4.6 million being 6.6 million. We’re not far from it being 8.6 million.”
Allenberg’s acreage estimate is exactly the same as Cotton Grower’s, but lower than the USDA projection of 13.2 million, and lower still than the National Cotton Council’s number of 13.5 million.